Cucchiaro: Go Broad, Own Shorter Bonds
In today’s risk-on/risk-off market environment, ETF investors are pressed to find just the right balance in their portfolios, and broad asset allocation could prove to be the answer, Stephen Cucchiaro, chief investment officer at Windhaven Investment Management, says.
Talking recently on the sidelines of IndexUniverse’s Inside ETFs conference with Cinthia Murphy, Cucchiaro argued that broad diversification is key, but so is exposure to fixed income in this current volatile environment. The icing on the cake would be liquid access to frontier markets, but that, he says, has yet to be made available.
IU.com: There’s a lot of talk these days about a prevalent risk-on/risk-off attitude in the market. That sounds a lot like we’re talking market timing. What’s this mentality really about, and what does it mean for ETF investors?
Cucchiaro: It's a short-term trading mentality. You're correct that it's not the way investors should think. By the time you see it's risk-on and you buy, you might be buying at the top. We think the risk-on/risk-off is really a result of two very strong but opposing forces that are at play, and both those forces are going to be in play for a long time. One is the debt de-leveraging force—all the debt that's been piled by the developed-country governments. And that de-leveraging force is very deflationary, very contractionary and that's where you usually get your risk-off feelings.
Combating that is the force of monetary stimulus. All the central banks have been setting their rates below the rate of inflation, so we have negative interest rates. We’re printing lots of money, and one bank is competing with another to see who can print money to keep their currencies from over-appreciating. That's a very stimulative force that helps support the economy and might even cause inflation at some point in the future.
So you have these two opposing forces, and sometimes one predominates, and sometimes the other predominates the news. What you get is this risk-on/risk-off volatility. We think it's important for investors to recognize that both forces are present—no one can predict perfectly what government officials and central banks will do in the future. And they need exposure that would help them if either force predominated.
IU.com: Meaning broad asset allocation right now is more important than ever?
Cucchiaro: More important than ever, yes, because it's more uncertain than ever what government officials and central bankers will do. And they have more influence into what's happening with these extreme imbalances in the global economy than before.
IU.com: In terms of asset allocation, does exposure to the bond market remain key? How should investors position their portfolios in the bond market today?
Cucchiaro: On one hand, you don't want to sell all of your bonds, because if we do go back into a global recession, bonds might be the only investments that hold their value. On the other hand, with the idea that we've been 31 years in a bull market in bonds, one can't expect the bull market to necessarily continue forever, and we could be facing the day sooner rather than later that interest rates go up.
So we have been focusing on carefully lowering the duration of the portfolios, looking at ways to still participate in fixed income in case we get into a recession, but without taking on undue risk of interest rates going up with high duration.
At the end of last year, we did take profits in some of our corporate and high-yield bonds that have done very well. We took profits in our long-term TIPS that we held for a two-year period, and they gained 34 percent as the real yields in long-term TIPS fell from 2 percent to zero. We thought it was great to take profits there. We've more recently added some exposure into not only lower-duration bonds, but also floating rates, which are even at the bottom of the duration ladder, in preparation for that day when interest rates start to tick up.
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